Finance and borrowing can be a frustrating mystery to navigate for many. There is much hearsay, misconceptions, and opinions available that can make it difficult to separate borrowing myths from truths. So here are 10 common borrowing myths we would like to dispel:
1. All Debt Is Bad
You might know of people who actively avoid all forms of debt and even refuse to use credit cards. They pay for everything with cash or on debit. Debt can really be classified into both good debt and bad debt. Debt in itself isn’t necessarily a bad thing, but more of a tool we can use to enhance our lives if we use it carefully and properly. Like many tools, it’s when debt is not used with respect or carefully that it can become disastrous.
Debt with high interest rates can be bad if it was taken without consideration of other alternatives. Borrowing without needing to, for uncontrolled personal consumption, can also be bad debt. But debt can be sometimes good for purchasing appreciating assets, such as a home, for example. Getting a mortgage is needed to purchase that asset.
Debt is also sometimes needed for necessary purchases, such as a vehicle to get to work. Sometimes we need to take on debt to help us with cash flow shortages. The key is to borrow within your means and make sure your future earnings can repay your debts within a timely manner.
2. Avoiding Borrowing and Credit Cards Will Help My Credit
There seems to be an existing misconception that never borrowing or using a credit card is the best way to maintain a healthy credit profile. This is actually the exact opposite of what is true. Never borrowing or using credit actually doesn’t make you appear more responsible to credit companies because in actuality you will have no credit history for them to gauge your creditworthiness.
Credit companies are not looking at if you’ve never had to borrow to determine your creditworthiness. They want you to borrow. That’s how they make money. What they are really interested in is your ability to borrow responsibly and pay back the loan. Your credit report is like a financial resume. You need to show experience of a good borrowing history to increase your score. If you have no documented experience of borrowing, lenders consider that a risk.
3. Closing Old Credit Cards Will Help My Credit Score
This myth has been around for a long time and is hard to get rid of. Closing old credit cards actually does not help boost your credit score and in fact will probably dent it. Closing a credit card can shorten your average credit history and also lower the amount of credit available to you. This in turn can cause your utilization rate to go up. All of these factors actually lower your credit score.
4. There Is a Universal Credit Score
Nope. There are literally hundreds of credit scoring models out there and not all of them even use the same grading scale.
FICO, for example, is commonly mistaken as a single credit score or “the” credit score. FICO is actually a brand of credit scoring models. Many lenders request a FICO score or use a FICO scoring system, but each of those lenders may have a slightly modified system with variances in factor weight.
Not all credit scores are FICO scores and many lenders even use their own proprietary credit systems using preferred criteria to match their particular business model. Depending on the type of credit you’re applying for, you may get a variety of credit score results, even from the same lender. Different financial products will have a different credit scoring formula to assess borrower suitability.
If you’re concerned about how then to possibly manage your credit score with so many models, don’t worry. Most models still consider the same basics, and if you have a great score in one model, you’ll likely have a good score on many others. You can read further in this article on why there is not a perfect credit score.
5. There Is a Credit or Borrowing Blacklist
There is no such thing. You may need to slowly build a history of good borrowing habits, but no one is precluded from doing so. Even if you’ve missed a payment, have defaulted, or have gone through bankruptcy, you can still rebuild your credit profile and get better rates once you’ve done so.
6. You Cannot Borrow Money with No Credit History, and You Cannot Build Credit History without Borrowing
Yes, it is tougher to get your loan application accepted if you do not have prior documented experience borrowing. But there are ways to build credit without history. Otherwise, no one would ever have credit.
Lenders look at each application based on merit. You might be able to borrow a small amount over a shorter loan term. You can get a secured loan or secured credit card. Student credit cards are available for those in school and looking to begin building credit. You can also have a co-signer with a well-established credit history help you apply for the loan. Building credit takes time and starts with small steps, but there are solutions available.
Once you’ve established credit, keep it healthy and it only gets easier from there.
7. I Can Simply Discharge My Student Loans if I Default on My Payments and Declare Bankruptcy
This is a terrible idea and unfortunately it’s a myth that seems to stick around. Student loans, whether private or federal, are very difficult to discharge even in personal bankruptcy.
Contrary to belief, student loan companies will not simply bend over to work with you if you miss several payments. If you default on your student loans, they have the right to come after you.
Defaulting on loans and bankruptcy isn’t pretty and will wreck your credit score for years. This can affect your ability to get an apartment, get a loan for a car, or get a mortgage. In some cases, it can even affect your eligibility to be hired for a job. And because student loans may not always be discharged in bankruptcy, you can still get your future wages garnished.
Avoid missing payments and work with your loan company to find a solution if you cannot to afford a payment.
8. All Credit Checks Hurt My Credit Score
Many people are understandably wary about sharing personal information, such as driver’s license details or a social security number, not only for security reasons, but because they are concerned about the impact of a credit check. But, it’s common practice for a lender or company to run a credit check to see if you’re eligible for funding and in fact is really needed to match your credit profile and get the most accurate quotes.
There are actually two types of credit checks conducted, soft inquiries and hard inquiries. Soft inquiries are very common and many are done even without you knowing. If you get a credit card mailer, for example, the credit card company likely ran a soft inquiry on your credit before sending you that letter. Soft inquiries do not affect your credit score. Checking your credit score or report, having your financial background checked for a job, or comparing loan offer quotes are all soft inquiries. Comparing mortgage loan offers on LendingTree, as another example, would also only be a soft inquiry.
Hard inquires do affect your credit score. Hard inquiries typically require your authorization and take place when you finalize a loan application with a lender, such as for an auto loan or mortgage, or whenever you apply for a credit card. Hard inquiries could lower your credit score by a few points and may remain on your credit report for two years. As time passes, however, the impact to your credit lessens and usually disappears before the hard inquiry even drops off your credit report.
9. If You’re Rejected or Unmatched for a Loan, It’s Over
Not necessarily. Financial borrowing is becoming a more tailored process and as lenders become more updated with technology, they will be better at matching more borrowers. Lenders also again consider merit and borrowing history when assessing loan applications, so to maximize your success of being matched, borrow within your realistic means and credentials.
A lender may sometimes also decide not to lend to you for reasons you may not be aware of or may not always lend you the full amount you’ve asked. It’s a good idea to check your credit report and ask a lender for particulars as to why you may not be qualified for what you’ve asked for. You might learn there may have been a credit factor you overlooked, or have set your expectations too high and are trying to over borrow without considering all the risk factors.
Other times, it may not even be your fault at all, but lenders simply have reached their set lending cap which they may reopen later. Once you understand your real position, try reaching out to lenders again and they may be more open to working with you.
10. Interest Rates are Set Firm and Non-negotiable
This is simply untrue in almost any given situation. Yes, your interest rate is determined by a number of factors, including current market conditions and your individual credit profile. However, interest rates can be open for negotiation depending on the lender you’re working with. This includes interest rate offers you get at a car dealership or when you’re looking to close on a home. Since lenders set their own rates, they can also change the rate at will to close a deal.
It is easier to negotiate a better deal if you have better credit, as you’re less of a risk factor, but even if you have a lower credit score, it doesn’t hurt to ask. Dropping 1% or even 0.5% on the interest rate can save you tons of money on a large purchase. Bringing in pre-qualified offers to the table or comparing loan offers from other lenders beforehand is a great way to negotiate a better rate or find yourself a better deal. Don’t sell yourself short by just accepting the first offer the realtor or sales agent gives you at face value.